BRITISH GAS DRIVES FOR BIG ROLE IN WORLD OIL AND GAS

Roger Vielvoye
International Editor

The metamorphosis of British Gas plc (BG) from a cash rich, state owned U.K. utility into a global oil and gas operator is turning the company into a major player on the world exploration and production scene.

BG has set an ambitious goal of generating 40% of its revenue from E&P and 20% from its global gas operations by the end of the century.

The remaining 40% will come from U.K. gas operations, which last year had revenues of 7.6 billion ($12.7 billion) and accounted for 94% of the company's income compared with only 6% from E&P.

To achieve its goal, the E&P division's revenues of 622 million ($1.04 billion) must show at least a 10-fold increase during the next 8 years, while expansion of BG's gas business must be even more dramatic.

With an operating budget of 800 million ($1.34 billion) this year, excluding funds for acquisitions, BG is in an expansionist mood not seen in other large oil and gas companies since the late 1970s and early 1980s.

E&P strategy gives priority to four core geographical areas of operation where development of reserves can lead to possible opportunities for the gas unit in gas distribution or power generation.

The core areas are the U.K. continental shelf; Northwest Europe and the Soviet Union; the U.S., Canada, and Caribbean; and Pacific Rim.

Outside the core areas BG is involved in oil exploration and production in countries where opportunities for gas follow-up do not exist. It is currently working on one of the biggest discoveries made in Egypt's Gulf of Suez in many years.

The process of change began with sale of the U.K. government's 100% interest in BG in 1986. That swept away controls restricting the company to activity in the U.K. and specifically excluding it from oil operations.

The BG board immediately began looking for ways to get into oil and build a portfolio of non-U.K. assets to reduce its dependence on the U.K. gas industry.

In a series of rapid E&P acquisitions, the company bought many of Tenneco Inc.'s international properties, U.K. independent Acre Oil, a 54% interest in Bow Valley Industries of Canada, and a share in Texas Eastern's U.K. properties.

As a result of the acquisitions and recent awards of new acreage, BG now has interests in 18 countries. Last year E&P business contributed 149 million ($248.8 million) in operating profits, compared with 42 million ($70.1 million) in the previous year. A very substantial increase in profits from E&P is expected when the company's latest results are announced next month.

The expansion of E&P profits contrasts with a downturn in gas supply, where operating profits slid to 867 million ($1.45 billion) last year from 1 billion ($1.67 billion) in 1989.

The acquisitions gave BG access to oil production of about 39,000 b/d, of which 30,000 b/d is in the U.K. Gas production is 425 MMcfd.

NEW ACQUISITIONS

The acquisitions brought people as well as properties. BG's E&P unit now has a staff of 1,600. Operations covering Europe, the Middle East, and Far East are run from London, while North America, the Caribbean, Africa, and Latin America are operated from Houston.

The initial E&P spending spree stopped at the end of 1989 and was followed recently by definition of E&P targets and global gas which last year made its first major acquisition abroad with the 565 million ($943.5 million) purchase of the Canadian gas distribution company, Consumers' Gas Co. Ltd.

To achieve BG targets the E&P unit will need to make further acquisitions. Howard Dalton, recruited from Amoco Corp. to be BG's E&P managing director, says acquisitions are still very much part of BG thinking. But it will have to be the right company, with the right assets at the right time.

Dalton was with Amoco for 30 of his 34 years in the industry, last as head of the company's Egyptian operations. Since his arrival in London last June, there have been no further acquisitions, to some extent answering criticism from the investment community that the cash rich BG lacked a coherent strategy in its headlong rush to become a world force.

Every time a major E&P company has gone on the auction block, BG has been named by the financial community as a possible bidder, most recently in the proposed Union Texas selloff.

Referring to the slowing in acquisitions since he came on board, Dalton said BG appeared to some people to have a shotgun approach to possible new acquisitions demonstrated by a willingness to go anywhere and do everything.

"One of the things I wanted to do was clear our own minds about what the company was trying to accomplish," Dalton said. "Money was not an issue, but I put a selfimposed restriction that we should not just go out and spend money but spend it in a focused fashion so we could monitor results and see if we were getting value for money."

Dalton said BG had looked at many possible acquisitions, a number of them very significant. But for one reason or another they had not worked out.

The biggest opportunities did not come neatly and cleanly and would have brought enough peripheral baggage that would have required sorting out later.

"We are looking for something that will slot into the existing operation reasonably well." Dalton said. "It's not a question of being unable to integrate people. We can do that, It's not a question of overall size. We can handle that."

One of the problems, Dalton said, was expectation of the market that outstripped companies' willingness to pay. "We have had a couple of examples in the U.K. recently in which properties the market thought would be attractive became available. But in the end there were no takers."

Dalton said he was attracted to a senior executive role at BG by the company's expansionist outlook and the amount of money the company was prepared to spend to achieve its targets.

Other E&P companies generally went through rationalization and retrenchment in the mid-1980s. Staff had been through redundancy programs and there was no longer the expansionist mentality seen in the late 1970s and early 1980s.

"There is still a sense of tenuousness in the marketplace," Dalton said. "People are still cautious and do not want to get too far in front.

"The opportunity I saw in British Gas was that they were 180' out of sync with the rest of the industry in general."

E&P EXPERIENCE

BG is no newcomer to E&P.

In the mid-1960s it joined forces with Amoco and Amerada Hess Ltd. to form one of the first groups to explore off the U.K. The result: discovery of giant Indefatigable and Leman gas fields in the southern basin of the North Sea.

The group went on to become involved in oil farther north in Beryl, Northwest Hutton, and Montrose fields.

As an offshore operator, BG found and developed the Irish Sea's Morecambe field, which has 4.5 tcf of reserves. There is another 1.2 tcf in North Morecambe. And as an onshore operator it found Wytch Farm oil field in southern England, Europe's largest onshore field.

But the uneasy relationship between the government and the state corporation in the early 1980s led to an order to sell the prized Wytch Farm holding-a serious blow to the morale of the E&P division-followed by removal of the North Sea oil assets to form the basis for Enterprise Oil, now a 2.6 billion independent in its own right.

The forced divestments were accompanied by government orders that restricted BG's E&P effort to the U.K. and Ireland and excluded it from applying for blocks in likely oil producing areas.

At privatization, Dalton said, BG had a reduced E&P operation in terms of oil reserves but still had the important assets of extensive gas properties in the U.K. and a team of high caliber personnel.

RESERVE BASE

The postprivatization strategy, while looking for synergy between E&P operations and the global gas business, also aimed to diversify BG's reserve base and get into the oil business.

Worldwide, excluding its interest in Bow Valley, BG has 6.778 tcf of gas reserves and 137.4 million bbl of oil. However, in the U.K. the forced divestment of oil assets has left BG with 88-90% of its reserves in the form of gas.

"That heavy proportion says we need to redress the balance and put more oil in the portfolio in the U.K. and worldwide," Dalton said.

"I have not targeted what would be the right balance. I think we would always have a bias toward gas. If we could go to areas that were gas prone but also offered an opportunity to play a role in gas distribution or in the power generation scene we would consider we had an excellent synergy, and that would work to the company's benefit.

"But it is difficult to put proper emphasis on the bias because at the same time we are looking at oil opportunities where we can make some money."

Looking at the core areas, Dalton said, the Caribbean had been included in the category with the U.S. and Canada because the company has 3.5-4 tcf of gas in Trinidad and the opportunity to discover two or three times that volume.

BG views the U.S. as the most important market in the world. Dalton said in some form the company wants to play a role in servicing the market.

As an extremely mature province, BG recognizes that the U.S. is a very difficult arena for a foreign company.

"Nevertheless, we are going to give it a whirl," Dalton said.

He said an acquisition will be required to gain a sizable foothold in the U.S.

"Our activity in the U.S. is small. We are working on some farmouts and participating interests, but it is on a small scale."

Part of the Houston team's task is to keep a weather eye on assets that might become available in the U.S. The emphasis is on gas production that is relatively long-lived.

Dalton said, "I think we appreciate the problem in the U.S. as well as anyone-outrageously low gas prices and a gas bubble that is more like a sausage. Nevertheless, we want to play a role in servicing that market. The one advantage we have is being mainly a gas company and a gas utility with staying power. We also have the cash.

"The only way to get a substantial foothold in gas reserves will be buying a company rather than trying to buy a series of properties."

Having taken a 54% interest in Bow Valley Industries, Calgary, Dalton said BG wants to increase its efforts in Canada, mainly the western part of the country, and concentrate on gas.

He said BG thinks, in the long run, there is a lot of gas in Canada. The E&P unit has an assignment to get into the business and support the global gas unit, which already has bought Consumers' Gas.

Because of its historical background, BG is most active on the U.K. continental shelf. That's where the acquisition of Acre Oil, a preemption share of Texas Eastern's attractive North Sea portfolio, and purchase of a number of blocks from Tenneco have made it the fourth largest acreage holder with interests in 87 offshore licenses totaling 126 blocks, 28 of them operated by BG. It has industry's second largest reserve base off the U.K. with 9.7 tcf of gas and 240 million bbl of oil.

Dalton said the 1988 purchase of Acre Oil with a wide variety of interests in production and exploration was a real springboard.

"We had quite a good database from our involvement in the Amoco-Gas Council group, but Acre had small interests in a wide variety of assets. Whether you have 1% or 90% you are entitled to the data. We had a tremendous influx of data into British Gas, something like 178 licenses."

BG, he said, has a sound base on which to expand in the U.K.

"We will continue to do that, but we also must keep an eye on the fact that we want to diversify from that base. "

Of the other core areas, Dalton said, the Pacific Rim is a must for any E&P company that wants to support a global gas business.

The company has acquired an interest in a large gas field being developed off Thailand by Total Cie. Francaise des Petroles. It also has exploration interests in Malaysia, where an exploration campaign will start this year, and Indonesia, where Bow Valley also has a part of the old Huffco operation.

The Far East is a good place to be, said Dalton, and one that will be of major interest to the company. In the final core area of Northwest Europe and the Soviet Union, Dalton is fascinated by the U.S.S.R.

"In my view there is no requirement to get involved in exploration because so much has been found and so much is available to be developed effectively it boggles the mind.

"The problem in the Soviet Union is sorting out the commercial arrangement. The chore in front of all of us is to structure a joint venture with the U.S.S.R. and the republics. The resources are there."

In the U.S.S.R., BG has several protocols with a number of agencies in parallel and is working on drafting commercial arrangements. He believes BG has an advantage from its relationship with Gasprom that goes back at least to the 1960s-earlier.

The old state owned British Gas Corp. was involved in pipeline inspection, technology transfer, and provided general technical assistance to BG. Dalton said there had been a tremendous exchange and interplay during the last 25-30 years. People had come to the U.K. for training and BG sent people to the U.S.S.R. The E&P relationship is quite new, but the long term relationship was there.

Dalton said oil and gas fields involved in negotiations with the Soviets are partially developed and will require capital and technical expertise to fully develop them or even half way develop them.

"They are technically difficult and very, very large. For total development BG would certainly be looking for a partner because it would take a tremendous amount of cash."

Dalton cannot fix a timetable on negotiations. However, he added, political events have to be unnerving.

BG also is looking into eastern Europe and believes it will be awarded two blocks in Bulgaria. The company is involved in other countries, including Romania.

NONCORE AREAS

Dalton defines noncore areas as unique opportunities to earn money in either oil or gas or both, but where there is no opportunity to get involved in the downstream business through BG's global gas unit.

The company has exploration or production interests in Egypt, Tunisia, Gabon, Pakistan, Ecuador, and Argentina and expects to participate in an offshore award in Angola.

The jewel in this crown could be an exciting discovery in Egypt, Dalton said.

"We have a very nice discovery in the Gulf of Suez on acreage we acquired through Tenneco. We are the operator with 50%.

"Our Egyptian company has just finished our first appraisal well, which was better than the discovery, so we think we have a nice development."

BG's Warda prospect is the northernmost discovery in the Gulf of Suez. It lies north of Amoco's October field on the west side of the gulf.

Dalton said it is a significant discovery in Gulf of Suez terms. BG has another Gulf of Suez block and a nine well commitment spanning 2 years.

In Tunisia, the company has modest onshore oil production.

It is negotiating with the Tunisian government to develop the offshore Miskar field, acquired in the Tenneco purchase.

The field has 2-3 tcf of reserves and could produce about 150 MMcfd for the domestic market. Negotiations are centered on the price to be paid for the gas.

Another area of interest is Argentina, where BG participated in the government's first round of privatization that covered secondary areas. It acquired four producing properties from YPF in partnership with local companies.

The properties were handed over the end of last year and, by introducing good reservoir management, production has been increased to 4,600 b/d from 1,500 b/d. Waterflood is also likely to be introduced.

Dalton said BG also is interested in the next round of secondary areas that will be made available later this month.